Banking institutions | Banking | Financial Literacy | Khan Academy

Whenever you're dealing with any type of a business, it's good to think about how that business actually makes money. Because then that helps you think about what are you paying for and what are you getting in return. This applies very much to the notion of banking.

Now, at a very high level, a bank—if we think about a Commercial Bank, a bank that most of us do business with—you give your deposits to the bank. The way that the bank makes money is that they keep some of those deposits as reserves in case people say, "Hey, I need to use some of that money." But then a large fraction of it gets lent out to other people.

The reason why they can make money doing that is they're going to give you some interest on your deposit, hopefully. But then, when they lend a lot of that money out, they're going to charge higher interest to the people that they're lending it out for. Those loans might be small business loans; it might be to buy a car; it might be for an actual mortgage.

Now, there's a lot of expenses when you do that. You have to have all sorts of technical infrastructure, computer systems. Many banks have branches; they have ATMs. Those cost real money. So when we think about banking, we should think about what type of Bank do you need because they have tradeoffs.

So the first I'll talk about are commercial Banks, and particularly the large National Commercial Banks. Think of places like Bank of America or JP Morgan Chase. Just like I just said, you can give them your deposits; you can get loans from them, and there's a lot that's useful about them. They have branches throughout the country; they have ATMs throughout the country, so it's very, very, very convenient.

But those have real expenses with them, so many times you're not going to get the highest interest rates from those types of institutions. But they are very much full service. Anything you might need, they are likely to actually offer it.

Now, you could go one step down; you could think about Regional Banks. Some people would call them traditional Banks. Regional Banks might be a little bit more focused on your part of the country, your region, your town. Those have some tradeoffs—you're not going to see branches wherever you go around the country.

But those Banks, those Regional Banks, might understand your context better than the commercial Banks or the large National Commercial Banks. They might be able to be a little bit more nuanced in how they lend or be a little bit more flexible in terms of the services they provide. They might understand your neighborhood a little bit better and make special cases.

Now, another type of bank that tends to be reasonably Regional are Credit Unions. Credit Unions, once again, are a place where you can place deposits, and you could also get loans from. Credit Unions are, for the most part, not actually for-profit companies. They are memberships; they are usually nonprofit organizations where when you put your deposits, you actually become a member of it.

So all of the profits are distributed to its members, which you could be. Because of that, the amount of interest you might get might be higher because they're not trying to maximize that, because at the end of the day, that profit is going to come to the members anyway. But there might be some limited services relative to especially the large National Commercial Banks.

Now the banks with the least overhead, the least expenses, are really a relatively new phenomenon over the last couple of decades, which are the online banks. They, for the most part, do not have branches; they might not have their own ATMs. Maybe they have partnerships with other National Commercial Banks to give you some access to your money.

You might say, "Well, why would I deal with one of those folks?" Well, the benefits that they have is because they have much lower cost structures. They oftentimes will give you much better interest rates; you can get much better interest on your deposits.

Now, the other trade-off is maybe some people aren't comfortable doing all of their banking purely online. They want to go to a branch; they want to see people. On the other hand, some people might say, "No, that's all I want. I just want online banking; I don't want to have to deal with anything else."

So as you go down your banking journey, actually, if you deal with any business, think about how they make money and think about the tradeoffs there. It's not that any one of these scenarios is better or worse; it's just that they might be more optimal or less optimal for different people depending on what you're trying to optimize for.